• Flattish earnings on slowed discretionary spend, high comparable base Aggregate revenue growth for the 13 names under our coverage was muted (+3% on average) in 1Q2016, as expected (-5% versus EFGe), as 1Q2015 included the two-month King-ordered bonus that bolstered spending, and consumption trends generally slowed. Recurring earnings (excluding eXtra that booked losses) were flat Y-o-Y, as margins narrowed on the impact of higher fuel and electricity prices, as well as strong promotional activity to spur demand. We prefer exposure to names with better growth visibility: our top picks are SADAFCO (strongest results set this quarter with earnings nearly tripling on commodity benefits and cost controls), Al Othaim (only retailer to post positive LFL growth) and Budget Saudi (cheapest stock in our coverage despite consistent earnings growth).
• Key themes seen in 1Q2016
-Structural food demand growth slowing: Food producers’ revenue was up only 1% Y-o-Y, with competition intensifying and consumers appearing to penny pinch. Almarai stood out, with 14% Y-o-Y top-line growth supported by newly-added bakery capacity and a surge in ex-KSA sales. Alarmingly, poultry saw record low growth as consumers shifted to cheaper frozen alternatives, signalling that consumers are being more price-conscious
-Discretionary retailers underperform remarkably: Discretionary retailers’ LFL sales contracted, hit by a high comparable base, with trends expected to remain depressed in the near term, in our view. The sector saw strong promotional activity across the board, but Al Hokair (the biggest miss this quarter, with the company barely breaking even) was particularly disappointing, with KSA gross margin down over 12pp Y-o-Y, as the company cleared overstocked inventory
-Grocery retail – a different story? Number two grocery retailer Al Othaim saw earnings up 14%, as LFL sales impressively grew in mid-single-digits. Conversely, market leader Panda (part of Savola Group) saw flattish revenue and booked losses as its aggressive expansion continued to weigh on results
-OPEX pressures reign: The hit from higher utility and transport costs was far-reaching, especially for food names (had it not been for favourable commodity prices, their earnings would have seen more significant pressure). Aldrees saw a hit to its transport division (recurring earnings -19% Y-o-Y) from higher diesel costs, but contract prices are being adjusted gradually
-Direct government exposure not a plus: Both Catering (-15% Y-o-Y) and Tayyar [-32% (uncovered)] saw earnings slump, indicating that companies with sizeable government/public sector exposure are suffering, partly on budget cuts, as well as a weaker tourism sector in the quarter
-Currency devaluation: Several companies with exposure outside the GCC were affected by weaker currencies, including Almarai, Savola, Al Hokair and Halwani. Sizeable EGP devaluation (c13%) in March 2016 means that all these names will likely see weaker translated revenue in the coming quarters

Hatem Alaa, CFA
Nada Amin